The South African economy is enjoying a boom of almost unprecedented proportions. Household spending is leading the way and firms are playing catch-up by investing in additional capacity to deliver goods and services. The public sector is adding to what is now a highly inadequate structure of roads, ports and railways.
What has made the extra growth possible is inflows of foreign capital — now running at an essentially modest rate of 2,5% to 3% of gross domestic product (GDP) a year. Extra capital is, of course, essential for growth — but faster growth is essential to attract capital. Until recently the economy did not grow fast enough to need extra capital.
How consistently fast the South African economy can grow will depend on the strength of the feedback loop from growth to capital flows. The Australians seem to be able to maintain consistently capital flows at the rate of 5% of GDP a year, while the Americans are not far from that rate themselves because policies in both countries are expected to remain foreign- and domestic-investor friendly.
South Africa, if it maintains its reputation and its higher growth rate, could hope for similar support from the savers of the world.
Faster growth will also help retain domestic savings for investment at home. After years of sanctions and exchange control South African wealth was unnaturally concentrated in the country and the case for diversification from South African-specific risk was a strong one. And so as much capital flowed out of the country over the past 10 years as was allowed to.
Slow growth helped encourage capital outflows and discourage capital inflows. These outflows culminated in the panic of 2001 that drove the rand to absurd levels that had nothing to do with economic fundamentals.
Yet the events of 2001 were cathartic. It took the extreme rand weakness of 2001 followed by the strong recovery to restore something like normality to South African balance sheets and mindsets.
With this behind us the rand can be expected to behave in line with the economic and balance-of-payments fundamentals. Or, in other words, the rand can generally follow minor inflation differences with our trading partners rather than lead them.
The strength of the world economy and its impact on commodity prices have also helped the rand recover.
When commodity prices fall away again, as they will one day, hopefully not soon, the rand will tend to weaken. When that happens inflation will tend to rise above its long-term trend and growth fall below that trend.
Yet it is not helpful to raise interest rates, as policy currently dictates, at a time when growth is slowing down and inflation is picking up temporarily.
It makes much more sense to ride out any exchange-rate shock, keeping interest rates largely stable to sus- tain growth. Hopefully when these choices come to be made the Reserve Bank will have earned its inflation-fighting credentials so that growth as well as inflation will receive attention. Indeed, faster growth is likely to mean more capital flowing in, a stronger rand and less inflation than would otherwise be the case.
What else can be done to address the poverty problem in South Africa? A full-frontal attack on poverty through first economy employment growth would allow employers much more Chinese-style freedom from regulation of wages and employment conditions and particularly the freedom to hire and fire. Unfortunately such options seem politically impossible, given the powers of organised labour to protect those in jobs at the expense of those trying to break in.
Some would argue that Chinese-style intervention in the currency market could solve the employment problem. The Chinese have resisted any revaluation of the yuan although its extreme competitiveness in world markets, especially in manufactured goods, would ordinarily have justified such as move. The undervalued yuan has made manufacturing in China highly profitable.
More importantly, these profits have been saved by the businesses involved and invested in additional production capacity. This process has naturally led to extra demands for labour from what has to date been an effectively unlimited supply. In other words, an undervalued exchange rate encourages production, savings and investment and discourages household consumption, because prices, especially of internationally traded goods, are higher than they would otherwise be.
A permanently undervalued rand could do something similar in South Africa, that is, discourage tax consumption and promote production, employment profits and business saving.
The exchange-rate effects can only be permanent if what is gained on the exchange-rate swings is not soon lost on the inflation of costs roundabout — especially wage costs and other charges.
This is easier to achieve in China, which has a closed capital market and weak trade unions, than in South Africa where market forces drive the capital and currency market and the Congress of South African Trade Unions rules in the labour market.
Without the ability to hold down wages while prices are rising with a weaker exchange rate, the operating profit margins would soon be back to where they were and the incentive to increase production and employment would soon dissipate, with only higher inflation and interest rates to show for the attempt.
Without meddling with the exchange rate or with import and export duties the country could achieve the same extra savings, investment and hopefully favourable employment results in a business-friendly way.
We could encourage business savings and investment by improving the after-tax returns and cash flows of South African business with much more generous and comprehensive tax allowances for investment spending and maybe also for employment creation.
Higher taxes on consumption would have to be substituted for lower taxes on production — as happens automatically when an exchange rate remains undervalued.
There is also a great deal more the government could do in addition to sound macroeconomic management to help the economy and employment.
This would be by improved execution of its functions.
The education and training system — if it could deliver an increased supply of well-equipped potential workers — would help to bring down real wages and real wage costs — and so promote competitiveness and employment. As would better roads, railroads and commuter transport systems.
Better ports, hospitals, courts, policing, sewage and water, and even statistics and parliamentary practice would increase the ability of South Africa’s businesses to compete for capital, skills and labour in the markets of the world.
Brian Kantor is an economist at Investec Securities